According to the International Energy Agency (IEA), $3.5 trillion USD of clean energy investments is needed each year through 2050 to offset the rise in carbon emissions. At the same time, an underinvestment in global infrastructure has restricted reliable access to key resources such as energy, sanitation and water.
A recent study, “The Financial Performance of Real Assets Impact Investments,” conducted by Cambridge Associates (CA) and Global Impact Investing Network (GIIN), shows that investments in real asset impact funds can profitably address both of these issues and help improve the livelihoods of billions of people.
In recent years, new asset classes have emerged that allow investors a variety of options for simultaneously pursuing financial and climate objectives. Such choices include clean energy mutual funds; green bond offerings; Environmental, Social and Governance (ESG)-focused Exchange Traded Funds (ETFs); and ‘green’ real assets.
Each medium presents investors with a set of different investment criteria that balance financial returns with the transition to a low-carbon future.
Since the financial crisis of 2008-09, key shifts have driven investor appetite for real assets such as infrastructure, property and agriculture upward. This growth has also increased demand for real asset impact funds which can include affordable housing, efficient properties, and sustainable infrastructure.
Real assets produce predictable cash flows and long-term capital gains, although they are highly difficult to move around from a financial standpoint. The main difference between real assets and other asset classes is that the value of real assets comes from its own properties, as opposed to being like a stock or bond that is a claim on another asset.
The CA/GIIN study demonstrated that the financial returns of real asset impact funds closely track those of conventional investments and in some cases exceed them.
Matt Leblanc, chief investment officer of OECD infrastructure investments at J.P. Morgan, said he sees growing investor appetite for the broader category of real assets due to strong performance and relatively uncorrelated returns.
“Direct real estate investments capture a substantial sector of the economy that is often underrepresented in traditional 60/40 [stock/bond allocations]. Many risks associated with infrastructure investments – including operational risk, weather risk, demographic risk, and regulatory risk – are unlike the risks found in a traditional 60/40 portfolio.” Leblanc said. These assets can increase the resilience of portfolios.
The majority of impact-focused funds address critical issues such as resource scarcity and climate change. This is in contrast to conventional funds that typically focus on more resource-intensive industries.
Impact-linked real assets can be managed using sustainable practices as a key lever in value creation. Benefits can include meeting the energy needs of a growing population by using renewable resources, enhancing worker productivity, and monetizing environmental stewardship.
To satisfy increasing investor interest, several recent developments have occurred. CA has introduced several real asset impact investing benchmarks that track the returns, size and impact of more than 800 funds, providing investors with a standard to measure against other sustainable and conventional investments.
The ImPact Network has launched a major marketing effort to transition some of the $35.0 trillion USD in wealth held by the world’s richest families to sustainable real asset strategies.
Marc Widger, managing partner at Greenhouse Property Company, said that sophisticated impact investors are looking for diversified portfolios, providing the real assets class with capacity for significant growth.
J.P. Morgan’s Leblanc similarly believes that an asset manager’s ability to incorporate sustainable business practices and adhere to ESG standards can provide them with an advantage in fundraising.
Leblanc said, “This makes sense, as ESG principles and financial performance typically go hand in hand: good governance is essential for effective company management, while understanding social and environmental impacts can help companies better engage with external stakeholders.”
The recent momentum in real asset impact investing appears justified by the results demonstrated by the CA/GIIN study, which covered 55 real asset impact funds from the years 1997 through 2014 divided into three categories: timber, real estate, and infrastructure.
Highlights of the report include the following:
- Sustainable timber funds produced internal rates of return (IRR) of 5.9 percent compared to the 3.3-percent return of conventional timber funds;
- Impact funds in the real estate sector experienced lower volatility than conventional funds, generating neither as much downside or potential upside;
- Infrastructure-focused impact funds produced a broad range of performance with a pooled net IRR of 0.3 percent compared to the 2.5 percent IRR of a broader universe of infrastructure funds.
Similar to results that have been seen in private-equity investing, the research conducted by CA/GIIN demonstrated the importance of fund-manager selection in investing.
While nearly one in four impact infrastructure funds in the study recorded an IRR greater than 10 percent, the bottom three funds produced IRR’s lower than -15 percent. Similar trends were seen in property-focused impact funds, where the top 25 percent outperformed conventional funds but the median was lower.
Other trends in the report demonstrated that smaller impact-focused real asset funds often outperformed larger funds in both their category and the broader universe of conventional funds.
In timber, funds below $100 million returned an IRR of 8.9 percent versus a combined return of 4.8 percent of comparative funds. Similar, real estate impact funds below $50 million returned 10.2 percent in contrast to the 6.3 percent returns of similarly sized conventional funds. Infrastructure-focused funds under $100 million posted a pooled IRR of 11.7 percent compared to a 5.3 percent return of a traditional infrastructure benchmark.
The CA/GIIN report also identifies that nearly one in four impact funds focus on real assets, according to two of the primary databases that track sustainable funds. This makes real asset-focused strategies one of the largest opportunity sets within impact investing, ranking third behind private equity/venture capital and private debt.
The universe of real asset impact investing is likely larger than just what’s been classified. Widger said he believes many real estate investors participate in impact investing without necessarily considering or realizing that their funds fall into such a category. With the rise of ESG standards, “the evolution of impact investing has occurred organically.”
The social and environmental goals of real asset strategies closely support the United Nations Sustainable Development Goals, particularly as they relate to decreasing the impact of climate change. The use of sustainability as a tool for value creation makes real asset impact investing an innovative financial option to combat climate change and lead to a low-carbon future.
Widger sees increased growth in real asset impact investing in both the near and long-term. However, it remains to be seen to whether investors will focus on explicitly impact-focused investments or more “traditional” investments that show adherence to ESG principles, said Leblanc.